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U.K. satellite broadcaster BSkyB intends to create a pan-European pay-TV business and has hired bankers to assist in a transaction to acquire Sky Deutschland and Sky Italia. It must be noted that 21st Century Fox owns a 39% stake in BSkyB, 57% of Sky Deutschland and 100% of Sky Italia. The Direct Broadcast Satellite Television segment of 21st Century Fox, which includes Sky Deutschland and Sky Italia, contributes less than 5% to its value, according to our estimates. In 2013, DBS contributed close to 16% to the company's overall revenues while it accounted for just 6% of EBITDA. Nevertheless, BSkyB’s transaction could give a cash boost of as much as $12 billion to 21st Century Fox, according to some reports. If the company does get such a cash boost, it would increase our price estimate for 21st Century Fox by more than 10%.

BSkyB is a satellite broadcasting, broadband and telephone services company with operations in the U.K. and Ireland. It is the largest pay-TV broadcaster in the U.K. and Ireland with over 10 million subscribers. The potential merger with Sky Deutschland and Sky Italia would give BSkyB access to a large subscriber base in Europe, and it can bid for pan-European rights to media content including sports and television series. However, regulators may oppose the deal on the grounds that it will give the company too much muscle in the European pay-TV market.

DBS has been a low margin business for 21st Century Fox. The segment’s revenues have grown at an average annual rate of less than 2% up to 2012. In 2013, Sky Deutschland was consolidated and this led to over 50% jump in DBS revenues. If we look at EBITDA margins, they have declined from 19% in 2008 to 9% in 2013. Moreover, the business involves high capital expenditures. More than 50% of the company’s capital expenditures were towards its DBS business in the past four years.

DBS revenue growth have two drivers: the number of pay-TV subscribers and the average monthly subscriber fees. Sky Italia’s subscribers have increased from 4.43 million in 2007 to 4.76 million subscribers in 2013. Sky Deutschland’s subscriber base stood at 3.45 million in 2013. Sky Italia’s ARPU has dropped over the past years from $71 in 2008 to an estimated $62 in 2013.

Our Forecast For DBS Business And Impact Of Acquisition

Going forward, we don't expect any significant change in 21st Century Fox’s DBS subscriber base. However, we estimate the ARPU to grow moderately and be northwards of $75 towards the end of our forecast period. This will translate into annual revenues of close to $8 billion by 2020. It must be noted that since the value contribution of DBS is very low, any change to our forecast will not have a material impact on 21st Century Fox's stock price.

As far as the BSkyB transaction is concerned, a cash boost of $12 billion represents the values of Sky Italia at around $7 billion and Sky Deutschland at around $5 billion (for Fox's 57% stake). However, we have been pessimistic on this segment and estimate EBITDA margins to grow moderately to 12.5% by 2020. This is because Sky Italia has been losing subscribers continuously in a saturated market. This implies that the pricing power may reduce due to fierce competition while programming costs will continue to rise. Moreover, the ARPU hasn't changed much over the past few years while costs have been rising.

BSkyB’s transaction thus will be a big positive for 21st Century Fox as it will not only provide a cash boost to the company but also allow BSkyB to expand in Europe and sign some juicy content deals aided by stronger negotiating power. 21st Century Fox will benefit from its stake in BSkyB.